Fed Likely to End Bank Funding Program in March, Wrightson Says

The growing gap between the rate on the Federal Reserve’s nascent funding facility and what the central bank pays institutions parking reserves suggests officials will let the program expire in March, according to Wrightson ICAP.

The Fed introduced the Bank Term Funding Program, or BTFP, earlier this year as the banking crisis roiled markets. The program allows banks and credit unions to borrow funds for up to one year, pledging US Treasuries and agency debt as collateral valued at par. The rate for these loans — one-year overnight index swaps plus 10 basis points — is currently 4.84% and 56 basis points lower than the rate for interest on reserve balances.

Since the Fed’s pivot earlier this month to forecasting more interest-rate cuts next year, OIS rates tracking them have tumbled, taking BTFP’s with them and boosting the attractiveness of the arbitrage trade.

The lower costs drove borrowings to a record high $131 billion in the week through Dec. 20, according to the latest Fed data. Rising usage, coupled with the arbitrage opportunity have led market participants to question whether the central bank will close this window for new loans that is set to expire on March 11, 2024, as bank funding conditions have retreated from extreme levels and its role as an emergency liquidity backstop has diminished.

“In justifying the generous terms of the original program, the Fed cited the ‘unusual and exigent’ market conditions facing the banking industry following last spring’s deposit runs,” Wrightson ICAP economist Lou Crandall wrote in a note to clients. “It would be difficult to defend a renewal in today’s more normal environment.”

Fed officials have yet to comment on whether the BTFP will be extended.